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Friday Five: 2 Bargains in Retail

Jason Stipp
Jeremy Glaser

Jason Stipp: I'm Jason Stipp for Morningstar. Welcome to The Friday Five, Morningstar's take on five stories in the market this week.

Joining me with the Friday Five is Morningstar markets editor Jeremy Glaser.

Jeremy, thanks for being here.

Jeremy Glaser: You're welcome, Jason.

Stipp: We had a lot of retail results this week. Let's start with Home Depot. They had fantastic results, so much so that you wonder if people are only shopping at Home Depot.

Glaser: Maybe it looks that way. After some really poor results at some of the apparel retailers, department stores like Macy's, we got great results from Home Depot: 5% same-store sales growth. This wasn't driven just by one region or one small area. It was nationwide. They saw a lot of strength across geographies and also across product categories--something that bodes well for them and is another sign of strength in the housing market as well.

Jaime Katz, our Home Depot analyst, thinks they even have more room to grow from here. When you look at their continued push into the more professional space and into e-commerce, you certainly see some potential upside for Home Depot.

Unfortunately, a lot of that is priced into the shares right now. We think they look a little bit expensive--not ridiculously so--but investors are probably better off waiting before diving in.

Stipp: Retailing giant Walmart also reported results. They've been in the middle of a turnaround. But they had some decent results as well. Are we starting to see their turnaround efforts paying off?

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Glaser: They have been in trouble recently and have been under the microscope. They did show some better results this quarter: 1.5% same-store sales growth in the U.S., which is a continuation of a trend. They're starting to get people back in the stores. That's positive. That came across a lot of discretionary categories. Grocery looked good for the first time in quite some time. So that was a real positive for the firm. They also raised guidance, something that the market was happy about.

They still are making big investments that have held down profitability. They are still dealing with issues like the strong dollar for their international sales. But Ken Perkins, our Walmart analyst, see signs that they are on track and thinks that right now the market just isn't pricing in the kind of growth that Walmart could continue to see and could get back to. When you look at things like their cost-efficient distribution network and their reputation for low costs, that's something that should translate online and should translate to smaller-concept stores. They are not getting credit for any of that right now, and he thinks this is an attractive entry point for investors given that the shares still are looking pretty attractive.

Stipp: TJX, another discounter, also reported, and they had a pretty good quarter. We're starting to see some themes where people are preferring discounts.

Glaser: Absolutely. TJX, which operates Marshalls and T.J.Maxx, had another good quarter, 5% same-store sales growth, just like Home Depot. The fact that they are a discount brand--and people are still looking for value--and that they are buying merchandise and inventory in season--so they already know what consumers want, instead of trying to guess--helped them again and was very much evident in this quarter.

Now, their stock actually has been under some pressure recently. As the rest of the apparel space has seen some issues, TJX has sold off with it. We think that's actually created a buying opportunity. So this might be one to take a closer look at.

Stipp: ConAgra was in the news this week because they are spinning off part of their business. This is a trend we've seen with some of the consumer packaged goods firms.

Glaser: ConAgra has been in the midst of a turnaround, and the latest step is that they are going to spin off some of their business that really focuses on selling into commercial food service versus directly to consumers. That spin-off, like you mentioned, follows a trend of consumer packaged goods companies trying to focus on their core brands, and that's the direction that they are going.

But Erin Lash, who covers ConAgra for us, thinks that this probably is not as much of a winning strategy for them as it has been for some of their peers. Because ConAgra has some of the second- and third-tier brands in a lot of categories, focusing on them doesn't automatically give ConAgra great brand equity all of a sudden, or a much better competitive advantage. They are still going to have a lot of struggles, even if these businesses are split apart. She doesn't see this as creating a lot of value.

Given that ConAgra shares are trading in 2-star territory, she thinks it's best to take a pass on this one.

Stipp: Lastly, this week we learned that Canadian Pacific is pursuing a merger with Norfolk Southern, but we think there might be some roadblocks on the track ahead.

Glaser: There will be some significant ones. This potential $28 billion deal faces a number of hurdles from Norfolk Southern agreeing to it, and probably more prominently getting through the regulatory regime and being allowed to merge.

There have been a ton of railroad mergers to get us where we are today in terms of the rational pricing that we've seen with Class I railroads, which is one of the things that underpins the wide-moat rating we have on all of the Class I railroads. When you look at a deal like this, you really have to question if it's going to be able to go through, and I think there is a lot of skepticism amongst some within the industry that it's going to happen. Some of that might be self-serving that they don't want to see a stronger competitor. But certainly, if it does happen, it would not be anytime soon. It would be a very long review process.

When you look at this exact combination, Keith Schoonmaker, who covers the rails for us, thinks that it really isn't about the two networks making a ton of sense together. He thinks it's about the Canadian Pacific management team, which we think very highly of. It's run by CEO Hunter Harrison, who is a former Morningstar CEO of the Year. They would be able to run it so much more efficiently, something that Norfolk Southern has been struggling with. If they are able to [run Norfolk Southern like] they are able to run Canadian Pacific, that could produce a lot of value. So, he thinks that's where the logic of this merger comes in.

But you have to file this under "developing." This is one that's going to take quite a while to play out.

Stipp: The Friday Five always keeps investors on track. Jeremy, thanks for joining me.

Glaser: You're welcome, Jason.

Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.